When you see that almost half of the companies in the Electronic industry in the United States have price-to-sales ratios (or "P/S") below 1.8x, Novanta Inc. (NASDAQ:NOVT) looks to be giving off strong sell signals with its 6.6x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

How Novanta Has Been Performing

Recent times have been pleasing for Novanta as its revenue has risen in spite of the industry's average revenue going into reverse. Perhaps the market is expecting the company's future revenue growth to buck the trend of the industry, contributing to a higher P/S. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

What Are Revenue Growth Metrics Telling Us About The High P/S?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Novanta's to be considered reasonable.

If we review the last year of revenue, the company posted a result that saw barely any deviation from a year ago. However, a few strong years before that means that it was still able to grow revenue by an impressive 49% in total over the last three years. So while the company has done a solid job in the past, it's somewhat concerning to see revenue growth decline as much as it has.

Shifting to the future, estimates from the four analysts covering the company suggest revenue should grow by 11% over the next year. With the industry only predicted to deliver 2.8%, the company is positioned for a stronger revenue result.

In light of this, it's understandable that Novanta's P/S sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Final Word

Typically, we'd caution against reading too much into price-to-sales ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that Novanta maintains its high P/S on the strength of its forecasted revenue growth being higher than the the rest of the Electronic industry, as expected. Right now shareholders are comfortable with the P/S as they are quite confident future revenues aren't under threat. It's hard to see the share price falling strongly in the near future under these circumstances.

A lot of potential risks can sit within a company's balance sheet. Take a look at our free balance sheet analysis for Novanta with six simple checks on some of these key factors.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.